Loan Modification

Pretend you’re a bank president. You have hundreds of millions of bad loans (option-arms) which you know will go bad when the loans reset. What do you do? If you do nothing, the loans will all go either into foreclosure or bankruptcy. And bankruptcy is only a stopgap; if they couldn’t afford the loan before the BK, they most likely still won’t be able to afford it, even if they dump the credit card debt (oops, more loan losses on our credit cards!).

As the loans end up in foreclosure, the bank’s solvency can go south. If it goes too far, the bank is then insolvent and is taken over by the FDIC. Bad news, both for our bank president and for the FDIC. The bank president loses his job, the FDIC has another problem bank to sell off. And if too many US Banks go south, what happens to our ability to borrow money from foreign banks and governments, to whom we owe Trillions?

But is there a better way? Ah, our esteemed president says, a little smoke and mirrors, a bit of sleight of hand. Magic! We allow the banks to take all the bad loans and put them into “loan modification status.” While there, they won’t be counted as bad assets, as their status is uncertain! Problem solved! The banks can now go about earning enough money to afford their foreclosures, and won’t have to foreclose any faster than they have profits to cover their losses.

But what does this mean for our poor borrowers? The bank has to keep the borrowers in “loan mod” without doing anything to take them out of loan mod until they’re ready. Well, you keep reassigning the loans to new processors. You change offices. You lose paperwork. You make impossible demands for data, for useless procedural requirements. Got to keep those balls all juggling in the air.

Of course, one must also ensure the borrowers can’t recover from the loan mod process. So one balances the requirement that “you must be in default to qualify for loan modification” with the desire to collect money first (trial modifications). What does the borrower do with the money he isn’t paying the bank? He can’t save it, or his loan modification would be rejected because he can afford the payment! So it gets spent, and there are no funds to cure the default.

And then the bank starts the foreclosure process. Out goes the 60-day pre-foreclosure letter now required by CA law. One then records the 90-day Notice of Default and Election to Sell Under Deed of Trust. One waits out the 90 days and you record the Notice of Sale, and continues postponing the sale as long as necessary. When it’s time to foreclose, one announces regretfully that “your loan mod application is rejected.” The bank knew this months ago, the borrower now learns the truth.

Of course, to make the scam (ooh….bad word!) work, there have to be success stories. So you waggle your finger at the banks (if you’re our esteemed president) and demand they show better faith in approving loans. They cherry-pick maybe 1-2% of the applications and approve those. And one puts lots of borrowers into “trial” loan periods, to get their hopes up. The statistics have told the bankers, though, that 35% of the approved loan mods will be back in default within a year.

And that, my friend, is the loan modification process. You may be one of the 1-2% of successful applications. You may not. All you can do is (1) submit–repeatedly– lots of documentation; (2) expect a lot of “stupid” decisions (think Dilbert’s pointy-haired boss!) and prepare to move when the loan modification is denied. And possibly file bankruptcy if: (1) you can afford the payments now; or (2) you have a second loan on your property taken out after your purchased it (which is not wiped out by the foreclosure).

Trying to force the banks to play fair is money down the drain. The Japanese had this process happen to them over 20 years ago, and haven’t yet fully recovered. Our esteemed president is trying to avoid that happening here. Your loans are just collateral damage, as the U.S. banking system tries to recover from its bad-loan lending binge of 2003-2007.

Gerald McNally is an attorney and real estate broker (licensed in the State of California) who specializes in family law, bankruptcies, business litigation, estate and tax preparation/planning located in the city of Glendale CA. He can be reached at 818-507-5100 or by email at: client@mcesq.com He offers complimentary seminars and consultations for those in need.